Western University
January 8, 2024
Science that deals with the allocation of scarce resources to satisfy unlimited competing uses (human wants).
Human wants: goods and services, including food, clothing, shelter, etc.
Resources are scarce
Science of constrained choices
Economics and other Social Sciences overlap in studying human behavior (choices).
Its approach distinguishes Economics from other Social Sciences
Maximizing behavior: Utility or profit function of the household, firm, union, or government
Market equilibrium: With varying degrees of efficiency, markets coordinate the actions of agents so that their behavior becomes mutually consistent (Prices)
Stable preferences: Preferences do not change over time and are not different between different types of individuals (wealth, nationality, culture)
The economic approach is not restricted to material goods and wants, not even to the market sector. Prices, be the money prices of the market sector or the “shadow” imputed prices of the nonmarket sector, measure the opportunity cost of using scarce resources (Becker, G., 1976, The Economic Approach to Human Behavior)
Economics is broadly divided into macro and microeconomics
Microeconomics studies the economic behavior of individual decision-makers: consumers, workers, firms, governments
An economic model is a simplified description of reality designed to yield hypotheses [predictions] about economic behavior that can be tested. (Ouliaris, 2011)
A model is supposed to reveal the essence of what’s going on. (Varian, H., 2016)
All models are wrong, but some are useful (Box, G., 1976)
The scientific method requires that every model yield precise and verifiable implications about the economic phenomena it is trying to explain
Formal evaluation involves testing the model’s key implications and assessing its ability to reproduce stylized facts
Economists use many tools to test their models, including case studies, lab-based experimental studies, and statistics
Variables taken as given that do not need to be explained by the model are called exogenous variables.
Variables determined by the model when the exogenous variables come into play are called endogenous variables.
Perfect competition
\[ \begin{align} \max_{Q} \pi(Q)&=PQ-C(Q) \\ \text{s.t. } Q&\ge0 \end{align} \qquad(1)\]
Agents:
Choices:
Constraints:
Exogenous variables:
Endogenous variables:
Agents: Firms
Choices: Quantities
Constraints: Positive quantities, producing more increases profits but it is costlier
Exogenous variables: Prices, profit function, total cost function
Endogenous variables: Quantities
Constrained optimization
Equilibrium analysis
Comparative statics
A decision maker optimizes its choice by maximizing (or minimizing) its objective function, taking into account the constraints on the choice
The solution to a constraint optimization problem depends on the marginal impact of the decision variables on the value of the objective function
Marginal value measures how a dependent variable changes as a result of one unit change of an independent variable
Comparative statics analysis is used to examine how a change in an exogenous variable will affect the level of an endogenous variable in an economic model
Comparative statics analysis can be applied to constrained optimization problems or equilibrium analyses
Perfect Competition
\[ P = \frac{dC}{dQ} \]